UNITED STATES
                            DEPARTMENT OF JUSTICE
           ________________________________________________________
    
              RETHINKING ANTITRUST POLICIES FOR THE NEW ECONOMY
                                       
                                     By:
                                       
                                JOEL I. KLEIN
                          Assistant Attorney General
                              Antitrust Division
                          U.S. Department of Justice
                                       
                                    at the
                       Haas/Berkeley New Economy Forum
        Haas School of Business, University of California at Berkeley
                          Portola Valley, California
                                 May 9, 2000
      _________________________________________________________________
    
    I am very pleased to be here today. I want to thank the Haas School
    and Dean Tyson for inviting me to address you about a subject that
    I've thought and even re-thought about a great deal over the past few
    years: the subject of this panel, "Rethinking Antitrust Policies for
    the New Economy."
    
    My conclusion is that the core principles of antitrust reflected in
    the Sherman Act -- like other fundamental principles embodied in
    venerable texts like the Constitution and the Bill of Rights -- should
    not be changed in this new era. All of these charters state enduring
    rules that can and should be applied in new situations. The Framers of
    the Constitution surely could never have imagined electronic
    eavesdropping; but the Supreme Court had no trouble ruling that this
    form of invasion of privacy was subject to the Fourth Amendment.
    
    Core antitrust principles have served our Nation, our citizens, and
    our economy extremely well in the more than a century since the
    Sherman Act was passed. And I expect that they will continue to do so
    in the 21st Century, during this period of remarkable technological
    progress and expansion.
    
    The core principles of antitrust are actually what Adam Smith wrote
    about more than two centuries ago: that free and competitive markets
    result in maximum economic development, wealth creation, and consumer
    welfare, but that markets will not always remain free and competitive
    in the absence of effective government oversight. In the end,
    antitrust is all about market power -- which every business
    understandably wants -- and the limits on how it can be obtained,
    preserved, and extended.
    
    The legitimate ways of acquiring and maintaining market power are
    essentially the same today as they were a hundred years ago; and the
    illegitimate ways are fundamentally the same as well. "Skill,
    foresight and industry" is the term that antitrust lawyers use to
    summarize the permissible means of acquiring market power. But I don't
    have to tell this audience that that simple phrase can capture a broad
    range of productive and profitable business activity, activity that
    has contributed so much to our Nation's economic strength. And market
    power can legally be maintained in the same way, through innovation
    and competition in the marketplace.
    
    The illegitimate means of getting and keeping market power have
    changed little since Senator Sherman's day as well. I will describe
    them in detail in just a bit. They deter innovation and restrict
    consumer choice, and they are as illegitimate and illegal today as
    they were a hundred years ago.
    
    Two important corollaries follow from all this: First, sound antitrust
    policy does not believe that big is bad or that success must be
    punished. Quite the contrary -- where success is the result of skill,
    foresight and industry, consumer welfare is enhanced. To be sure,
    there have been times when antitrust enforcement has appeared to take
    a different view. For example, during the 1960's, the Division
    sometimes disregarded sound, market-based antitrust analysis in favor
    of a big-is-per se-bad philosophy. But that view fell out of fashion
    decades ago, and there is little prospect of its revival.
    
    And second, since we believe that free and competitive markets
    maximize innovation and consumer welfare, we tend to disfavor
    regulation generally and certainly as a way to remedy abuses of market
    power. Ongoing regulation is invariably inefficient, both because it
    under-deters anticompetitive behavior and because it can be exploited
    by opportunistic rivals to hamper procompetitive conduct. Thus, where
    possible, we seek structural, market-based solutions to serious
    competitive problems, because these solutions mean that consumers, not
    government agencies or existing monopolists, will get to chose when
    longstanding monopolies yield to innovative technologies and
    innovative business models.
    
    In this regard, I've been reading a lot lately about this issue of
    regulation versus structural solutions -- as it affects a case of some
    interest to me. It's a case that is well known to many of you as well,
    I'm sure. It involved complex and wide-ranging antitrust claims,
    resulting in a trial that gained lots of attention, followed by a
    Justice Department proposal to break-up a major American corporation.
    
    Here's what the Wall Street Journal had to say about the case on its
    editorial page:
    
      "While the Justice Department can't promise any consumer benefits
      that might result from its suit to break up [the company], it is
      sure of one thing: This is the largest antitrust action ever filed.
      So much for the mentality of modern-day trustbusters. As long as
      they can tackle the biggest of all 'big businesses,' what is the
      difference whether the massive expenditure of federal money and
      effort is likely to cut anyone's . . . bills?"
      
      "Where is the problem that justifies risking possible damage to the
      efficiency of a vital part of the U.S. infrastructure; damage to
      the investments of innumerable small investors and pension fund
      beneficiaries; possible damage to an important research and
      development enterprise? If there is a problem that justifies all
      this we can't find it. Maybe it is because we prefer to deal in
      economics, rather than politics in such matters."
      
    By now, you may have guessed that this is an editorial about the
    Department's monopoly maintenance case against AT&T, a 1974 editorial
    as a matter of fact; but if it sounds familiar, it is because the same
    charges have been leveled against the Department's lawsuit, and our
    proposed remedy, in the Microsoft case.
    
    Then as now, the Department challenged illegal practices by a firm
    with monopoly power in a critical market, practices designed to
    maintain and extend the monopoly.
    
    Then as now, the Department was criticized for challenging a
    technology leader and a critical part of the economic infrastructure.
    
    Then as now, the Department sought a structural remedy because it is
    the most effective and efficient means of protecting and preserving
    competition.
    
    And then as now, dire predictions were made that structural relief
    would kill the goose that laid the golden egg. One of my favorites is
    a Forbes Magazine article published the day after the AT&T divestiture
    took place: "For the consumer, costs will go up and service down . . .
    It's quite alarming, in fact, just how many top executives in the
    industry are predicting [this] . . . get used to it; it's going to get
    worse."
    
    We now know, of course, that the divestiture in the AT&T case, far
    from making things worse, has unleashed unprecedented competition,
    innovation and consumer benefit. By separating the local telephone
    monopolies from other aspects of the telecommunications business, it
    has fostered the growth of the Internet, wireless communications,
    broadband services and fiber optics, and other extraordinary
    innovations that were unimaginable when the divestiture took place.
    
    And it has also led to substantial competition in telephone services
    and significantly lower prices for consumers. Since divestiture,
    prices for long distance calls have fallen dramatically, while per
    capita use of long distance service has almost tripled -- an
    extraordinary output effect by any standard.
    
    We believe that the proposed divestiture in the Microsoft case
    similarly would produce substantial innovation and competition in the
    software business. The district court found that Microsoft illegally
    maintained its operating system monopoly through a broad pattern of
    unlawful acts that crushed emerging threats to that monopoly posed by
    Netscape's browser, Sun's Java, and other cross-platform middleware
    technologies. We need to make sure that new technologies aren't
    subject to the same treatment in the future or, even worse, that
    innovators decide to avoid such technologies altogether for fear that
    they may meet the same fate if things don't change.
    
    The central feature of our proposed remedy is splitting Microsoft into
    an operating systems company and an applications company. Unlike the
    AT&T case, where line-of-business restrictions remained on the local
    telephone companies, here the separated businesses would be entirely
    free to compete with each other in all lines of business. Each company
    would have the incentive to compete vigorously through developing and
    licensing products that compete with the other's core business.
    
    For example, a separate applications company would have the incentive
    to develop the best possible office suite, not only for Windows, but
    also for other computing platforms like the Apple and Linux operating
    systems. Indeed, much like the browser was in 1995, before Microsoft
    commenced its illegal campaign, Office has the very real potential to
    be a cross-platform middleware threat to the dominance of the Windows
    monopoly.
    
    Because Office is an enormously popular product -- with over 100
    million copies in use around the world -- its availability on other
    operating systems would give those operating systems a real
    opportunity to compete against Windows. As these other computing
    platforms grow and proliferate, moreover, we would expect the Windows
    operating systems business to face real competition for the first
    time. And this is only one of several ways in which the proposed split
    is likely to facilitate competition. In toto, the result will be
    exciting and innovative new products, with more choices and lower
    prices for consumers.
    
    Now, there are some who are suggesting that the reorganization will
    result in a loss of efficiency currently generated by the coexistence
    of the operating system business and the applications business under
    one roof. That argument is wrong as a matter of fact, and wrong as a
    matter of history as well. It is wrong as a matter of fact, since the
    two companies would be free to exchange technical information, as long
    as that information was also made available to third parties; and
    Microsoft has long claimed that it provided third-party applications
    developers all the information about its operating system that those
    developers could need to write their applications for Windows. If so,
    there should be no real loss of efficiency in the reorganization.
    
    The argument is also wrong as a matter of history. The opponents of
    the AT&T remedy made the very same claim, arguing that the divestiture
    would imperil the efficiency of the telephone network; and that
    argument has surely failed the test of time.
    
    Now, let me move away from this specific example of "the more things
    change, the more they stay the same" to the more general point about
    antitrust enforcement that I referenced at the beginning of my
    remarks. While technology changes, and that of course affects the
    particulars of our analysis, antitrust enforcement remains remarkably
    constant in its application of the core principles that have proven to
    be effective in protecting and preserving competitive markets while
    maximizing innovation and assuring low prices for consumers. These
    principles, as I noted earlier, have to do with market power and
    separating the legitimate, procompetitive ways it is acquired and
    preserved, from the illegitimate, anticompetitive ways.
    
    Let me reiterate the fundamental point: businesses want market power
    -- i.e., the ability to make more than normal, competitive profits.
    It's good for the business, good for its employees, and good for its
    shareholders. And a rational, procompetitive system of antitrust laws
    must seek to ensure that the way business gets that market power is
    good for consumers as well.
    
    To take an obvious example of a good way of acquiring and protecting
    market power, one from outside the antitrust arena, though by no means
    inconsistent with it, let's look at patent law. Here is an example
    where we grant statutory protections that tend to create and protect
    market power. That is why drugs cost so much -- absent patent
    protection, once a drug is created, it could be duplicated and readily
    sold at a small fraction of its patent-protected-price. The rationale
    behind patents, and the market power they establish and protect, is
    that, in the absence of patent protection and the returns it
    generates, no one would spend the money on R&D necessary to develop
    the drug in the first place. In short, we create a legally imposed
    barrier to entry -- intellectual property (or IP) protection -- in
    order to ensure that innovation is encouraged. One can argue, as many
    do, whether the period of IP protection is too long or too short to
    stimulate a desirable level of overall R&D, but the basic principle
    that, absent some IP protection, innovation would be harmed is clearly
    correct.
    
    The next point I want to note here is that market power is not a
    unitary thing: there is market power and there is market power. Lots
    of businesses enjoy at least some market power, but very few enjoy
    monopoly power over any significant period of time. Brand loyalty or a
    first-mover advantage, for example, may give a business the ability to
    charge prices a bit above the competitive level, but in the absence of
    stronger barriers to entry than just brand loyalty or a simple
    first-mover advantage, the magnitude of these supracompetitive profits
    are likely to be quite modest.
    
    This point, in turn, is key to understanding a fundamental market
    dynamic that animates antitrust analysis, i.e., the strength of
    barriers to entry is ultimately what determines how much market power
    a business will be able to sustain and exploit. At the same time, and
    somewhat paradoxically, the more a business exploits such power, the
    more potential competitors want a piece of the action. In short,
    supracompetitive profits, like well-known movie stars, draw a crowd;
    businesses, just like the bank robber, Willie Sutton, want to be where
    the money is.
    
    And, in fact, as it turns out, because of the powerful incentives of
    the marketplace, it's quite rare that we see strong barriers to entry
    enduring for long periods of time. That is especially true in the
    absence of illegal business practices that augment the natural
    barriers that exist, a point that I want to come back to in a moment
    because it is at the heart of what antitrust enforcement is all about.
    But this view about the strength of entry barriers, at least in
    certain critical industries, has not always been widely shared. On the
    contrary, there have been quite a few times in our history when entry
    barriers to particular markets were thought to be so strong, we
    concluded that the market was a so-called "natural monopoly" and that
    we had no choice but to regulate it. Indeed, not so long ago, that was
    the case with respect to surface and air transportation, telephones,
    and energy (and as to the latter two, still is the case to some degree
    even today).
    
    But now, with increasing confidence and conviction, we in America (and
    much of the world as well) have been won over to the view that, in the
    absence of illegal practices, technology will ultimately be able to
    erode almost any barrier to entry. Consequently, for several decades
    now, we have wisely adopted a national policy that favors deregulation
    and market forces instead of regulation.
    
    This is not to suggest that market forces cannot generate strong
    barriers to entry. They can, especially in markets characterized by a
    so-called positive feed-back loop, either from scale economies or from
    what economists call "network effects." What this fancy jargon means
    is something we all tend to understand intuitively: in certain
    circumstances, nothing succeeds like success. A network effect occurs
    when the more a business sells of a particular product or service, the
    more people want it because its increasing adoption increases its
    value to the next user. A classic example, of course, is the
    telephone: the more people on a given network, the more value the
    network has to potential users, making it easier to get the next
    customer, and so on. Indeed, once a network gets a sufficiently large
    number of customers, it becomes almost impossible for a new entrant
    without access to the network to successfully challenge its dominance.
    
    Two things I want to emphasize here about these kinds of positive
    feedback situations: first, they existed in the old economy, just as
    they do in the new. We had an old-economy case against AT&T, for
    example, where market power was derived in this fashion. And our
    new-economy case against Microsoft relies on this notion as well.
    
    Like the telephone system, the Windows operating system at issue in
    the Microsoft case also benefits from a positive feedback loop. People
    select an operating system based largely on the number of applications
    available to run on that operating system, and people who develop
    applications want to develop them for the most popular operating
    system, since that is the way to sell the most applications. As a
    result, a dominant position in operating systems reinforces itself
    because the applications developers write to your operating system and
    then more new computer buyers want your operating system because
    desirable applications are available to run on it.
    
    The second point to understand about these positive feedback loops is
    that there's nothing illegal or even undesirable about them: they are
    an outgrowth of market forces and consumer choice and, so far as the
    antitrust laws are concerned, businesses which have the skill and
    foresight to understand and take advantage of those forces are
    entitled to enjoy the fruits of their efforts.
    
    In both AT&T and Microsoft, antitrust enforcement became an issue not
    because of the acquisition of market power but because of how that
    power was protected and/or expanded. This is a fundamental point to
    understanding the future of antitrust enforcement and so, in the time
    that remains, I would like to expand on it briefly.
    
    As I have noted, we in America have chosen, wisely in my view, to
    reject an effort to regulate all monopolies; instead, we generally put
    our faith in the ingenuity of the market -- entrepreneurs and
    innovators -- to erode barriers to entry and protect consumer welfare.
    But if monopoly power, once had, can be used to protect and extend
    itself, our reliance on the market will be frustrated and consumers
    will be hurt. Unlike positive-feedback-loops, which are a natural and
    inevitable market phenomenon, abuse of market power is anticompetitive
    and harmful; it means that a monopoly position has prevented
    innovation and entrepreneurship that would strengthen the economy and
    increase consumer welfare.
    
    What's interesting in this regard -- and this is why I say that the
    new economy is fundamentally no different from the old when it comes
    to antitrust enforcement -- is that the anticompetitive techniques
    used to protect and extend monopoly power in the new economy are
    essentially no different from those used throughout history. Put a bit
    differently, while technology changes, human nature, as Adam Smith
    taught us long ago, does not. There are, to paraphrase Simon &
    Garfunkel, only so many ways to illegally hurt your competitor.
    
    In our business, there are generally about a half-dozen or so of these
    techniques and they are used in the new economy in much the same way
    that they were used in the old. Let me first mention the basic
    techniques and then illustrate their application by referring to cases
    involving the new and old economies, mentioning for illustrative
    purposes three that are currently in court. The basic techniques --
    apart from good old fashioned collusion in which potential competitors
    agree not to compete -- typically involve cutting off competitors'
    access to important suppliers and markets, inducing rivals not to
    compete, using tying to force customers to purchase other products,
    and engaging in predatory tactics to raise rivals costs or cut their
    revenues without a real business justification. Basically, these are
    the time-tested tricks of the monopolist's trade.
    
    Let's take a quick look at several of them. First, there are the
    traditional anticompetitive distribution techniques: intimidating or
    coercing distributors who need your monopoly product, either
    informally or through formal exclusionary contractual arrangements.
    These kinds of practices are as old as the antitrust laws themselves
    and rest on the sound premise that the use of market power to restrict
    distribution of competing products can only injure consumers. That
    point is at the heart of our complaint in the Dentsply case, a very
    old economy case involving false teeth and exclusive dealing contracts
    with dental labs. It was also a key issue in the Microsoft case where
    the judge found that Microsoft repeatedly intimidated OEMs who wanted
    to distribute competitors's products and used exclusionary contracts
    with Internet Access and Content Providers to limit their distribution
    of the Netscape browser.
    
    A second common, anticompetitive distributional practice involves
    tying two products together -- once again, a violation as old as the
    antitrust laws themselves. Tying allows a firm to use its market power
    in one product to force consumers to take a second product and thus
    often makes it harder for the firm's competitors to distribute their
    products. To be sure, a tying case can present complex factual issues
    about whether there are one or two products at issue, which in turn
    can raise important questions about potential integrative efficiencies
    that might result from a "tie." But distributional efficiencies --
    i.e., simply putting two products together -- are no defense to tying.
    That was true in the 1930s when a unanimous Supreme Court ruled that
    IBM's decision to tie calculating cards to its calculator was unlawful
    and that was also true under the District court's opinion in Microsoft
    involving the tying of Microsoft's browser to its monopoly operating
    system.
    
    Since a lot of discussion has focussed on the tying issue in
    Microsoft, let me emphasize that ties in the software industry,
    especially where, as in our case, the tied product (e.g., browsers)
    could undermine the monopoly position of the tying product (e.g.
    operating systems) can have particularly strong anticompetitive
    effects. In this regard, we need look no further than the remarks of
    Microsoft's Chief Operating Officer of Microsoft when he was asked in
    1998 how small software companies could compete on products that
    Microsoft plans to fold into its operating system. His reply: these
    smaller rivals had three possible paths -- they could fight a losing
    battle, they could produce a successful product and then sell to
    Microsoft or another large company, or they could "not go into
    business to begin with because, hey, if you're a betting person, you
    know which way it's going to go." It's hard to think of a greater
    deterrent to innovation.
    
    The next set of traditional antitrust violations involve what we call
    predatory, as distinguished from exclusionary, practices. Here we're
    talking about a business incurring expenditures that would be
    profitable only if they will defeat a competitor and then allow the
    business to recoup the short-term costs of the action through the
    long-term preservation of monopoly profits. And here again, these
    practices were used in the old economy as well as the new, a point
    readily demonstrated by the fact that this issue is at the heart of
    our American Airlines case and was key in Microsoft as well.
    
    In the American Airlines case, we charged that, when faced with new
    entrants in Dallas, American incurred great expense -- by saturating
    the relevant city-to-city markets where the new entrant had started
    service (e.g., Dallas/Wichita) and lowering prices substantially -- in
    order to drive the new entrant from the market. The essence of the
    case is our claim that American would never have engaged in these
    practices had it not known that it could eliminate new entrants and
    then recoup its short-term losses by enjoying monopoly profits in the
    future. As American's CEO said to his colleagues at the time, "if
    you're not going to get them out [of the market], then [there is] no
    point to diminish [our] profit."
    
    Moving next to the new economy, the facts of the Microsoft case
    provide an especially powerful example of this predatory technique.
    There, the judge found that Microsoft had spent hundreds of millions
    of dollars to develop and distribute Internet Explorer, not just for
    Windows but for Internet Access Providers and even for Apple.
    Microsoft did this, the court further found, even though it internally
    described IE as a "no-revenue product" and knew that, standing on its
    own, Microsoft's IE business strategy made no sense. After all, it's
    hard to sustain a business plan by paying millions of dollars to
    induce others to distribute a no-revenue product, especially one that
    cost hundreds of millions to develop. What made this strategy even
    more perplexing is that, according to Microsoft's own documents,
    "browser market share" -- share of this no-revenue product -- was seen
    a "priority number 1" within the corporation.
    
    The reason this otherwise irrational business strategy made sense, of
    course, is that, as the district court found, Microsoft was protecting
    its monopoly profits in Windows by making sure that Netscape's browser
    did not obtain sufficient market share to create a platform that could
    ultimately erode Windows' dominance -- a fear that Bill Gates
    highlighted at the outset of Microsoft's anticompetitive campaign by
    noting that, if Netscape wasn't stopped, its browser would be able to
    "commoditize" the operating system.
    
    I could give other examples of anticompetitive practices in the new
    economy -- like withholding technical information that competitors
    need to compete -- which were also observed in the old economy. But by
    now I think you get my basic point: when it comes to antitrust
    enforcement, the new, new thing isn't so new after all.
    
    So let me conclude by highlighting two points. First, the focus of
    antitrust enforcement tomorrow, as it was yesterday, will remain on
    preventing the traditional anticompetitive techniques that businesses
    with market power have long used to maintain and extend that power.
    And second, given my first point, in the new economy as in the old,
    businesses with market power should have little problem in ordering
    their affairs in a way that keeps them free from antitrust
    difficulties.



%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%